FRD: A Steel Net-Net (Update)

Normally I wouldn’t write an update so soon after my first post, but Friedman announced some interesting news last week along with its fourth quarter earnings.

The results for the quarter itself were mixed, with a $4 million impairment charge hitting their tubular segment. The investment they had made in a tubular facility a few years ago never really worked out. Excluding that charge, net income was modestly positive in the quarter.

For the year, the company posted their worst earnings year in over over a decade, losing about $5 million. The impairment write-off drove the majority of the loss.

While the coil segment is performing fine, I’d expect the tubular segment to struggle for a while. This segment is levered to the struggling energy sector. And they have a good amount of tubular inventory which will take some time to work through. The company also noted that COVID will have an impact across both segments, and they expect to lose money for the June quarter.

On the positive side, it appears that there are operational improvements underway. In my last note, one source of hope for the company was that new CEO Mike Taylor could make long-needed operational changes at the company.

It seems like he is making some of those changes. The company completed a strategic review last year with a few tangible improvements underway.

The first improvement is that they are making capital expenditures to boost capacity where they have been constrained. Overall they will spend $5.8 million, of which $3.8 million has already been spent. Given their last big capex project was just written off with a large impairment charge, we should be a little skeptical. But I also appreciate the initiative to try to grow.

The second improvement is Friedman will start to use price-risk actions to hedge their steel exposure. This hedging will lower their earnings volatility. This makes a lot of sense. As I said before, there is no reason a company like this should not consistently earn money.

The last major improvement is that the company announced a share repurchase authorization of 1 million shares or so, or about 15% of the company over the next three years. This is meaningful–if they actually follow through. Repurchasing shares at 55% of tangible book will be highly accretive.

The company is still in a black-out period. So it wouldn’t be able to purchase shares until mid-August or so after they report their next quarter. Just for reference, the company traded about 2.7 million shares last year. So it would require a daily purchase of 12% of daily volume to complete the buyback.

After the quarter, the company took in a PPP loan for $1.7 million, which will probably be forgiven. This will help offset the loss from the June quarter.

What does all this mean for earnings? It’s hard to triangulate given the information we have. In the past decade the company has earned about $25 million in total, or $2.5 million per year. Most of that occurred in the 2011-2015 period, with virtually nothing earned from 2016-2020.

If we assume 7% gross margins on $150 million of sales less $5 million of opex, we can get a $5 million earnings figure. This could be reasonable given what they have done in the past.

Earning $2.5 million relative to a market cap of $36 million is not particularly enticing value. Earning $5 million would change the equation. And if they return capital via buybacks along the way, the earnings yield would ramp up even more.

Will any of this happen? I can’t say for sure. But the downside does seem limited. As I said two weeks ago, it’s a heads I win, tails I don’t lose much situation. But maybe the odds on the coin flip are no longer less than 50%? As a net-net investor, I can only hope.